Fed rate hike hint prompts US stock decline

US stocks fell sharply yesterday after the Federal Reserve said it would hold interest rates at the lowest level since 1958 but indicated it might be closer to a rate hike.

The Dow and Nasdaq indices fell for the second straight session after hitting 2½-year highs on Monday,erasing their gains of the past two weeks.

The Fed opted to hold the federal funds rate for overnight loans between banks at 1 per cent, as anticipated, but policy- makers altered a pledge made in August to keep rates low for a "considerable period" and said instead they "can be patient" before implementing what would be the first rate increase since May 2000.

"I think people may use this as an excuse to take some profits," said Mr Michael Murphy, managing director at Wachovia Securities. "Up until now every time the market's tried to sell off, the buyers would appear and they'd turn the market before there was a meaningful correction." The US central bank's policy-setting Federal Open Market Committee (FOMC) instead said it "can be patient" about lifting its key overnight bank-lending rate target.

The Fed left the federal funds rate target at 1 per cent - a position it reached in June - but heightened a sense that policy-makers were preparing the ground for eventual rate rises, however vague the timing of any action might be.

In a statement at the conclusion of a two-day meeting, the FOMC said economic activity was on the upswing since its last meeting on December 9th, implying it felt more certain about a sustained recovery from the 2001 recession. "The evidence accumulated over the intermitting period confirms that output is expanding briskly," the FOMC said.

"Although new hiring remains subdued, other indicators suggest an improvement in the labour market."

Stock prices fell and the dollar rose in value against other key global currencies in the belief that higher US interest rates were nearer. However, some analysts cautioned that the change in wording might not be a clear-cut signal.

Some Fed members had previously expressed concern at the idea of saying rates would be held low for any fixed period, so substituting patience might be a way of easing those worries without committing to any specific timing on a move.

The Fed did not help clarify its new language. "With inflation quite low and resource use slack, the committee believes that it can be patient in removing its policy accommodation," the FOMC said without elaboration.